Dollar falls vs. euro with U.S. stocks on Lehman

By Nick Olivari

NEW YORK (Reuters) - The U.S. dollar fell against the euro on Monday amid increased risk aversion after Lehman Brothers Holdings Inc LEH.N filed for bankruptcy protection, spurring a stock market sell-off, and had its biggest one-day loss against the yen in nine years.

The dollar had managed to hold gains against the euro for most of the New York session, but as Wall Street benchmark indexes extended losses in late trading, the U.S. currency fell in their wake.

Investor attention is now focused on American International Group (AIG.N), once the world's largest insurer, for clues as to whether there are other companies that may need to raise capital to cover mortgage-related losses.

Treasury Secretary Henry Paulson said on Monday the U.S. financial system remained sound despite current stresses and he was prepared to take further actions if necessary to maintain stability.

"So far, the efforts of the U.S. government have failed to bring any stability to the financial markets," said Kathy Lien, director of currency research at Global Forex Trading.

The euro rose 0.2 percent to $1.4256, though it remained off its session high of $1.4479.

The ICE Futures U.S. dollar index .DXY, which measures the dollar's performance against a basket of six currencies, rose 0.2 percent to 78.529 after climbing as high as 79.360.

CARRY TRADES UNWOUND

The rise in risk aversion led investors to unwind carry trades, which are funded by borrowing in the low-yielding yen.

The dollar fell to a low on the day at 104.55 yen and at one point had its biggest one-day loss in over nine years, according to Reuters data. It was last down 2.8 percent at 104.85, while the euro dropped 2.5 percent to 149.50 yen.

Seen as a safe haven, the Swiss franc rose against the dollar, which fell 1.4 percent to 1.1141 francs.

Lehman's bankruptcy protection filing made it the largest and highest-profile casualty of the global credit crisis.

At the same time, the market was also digesting news that Bank of America (BAC.N) had agreed to buy Merrill Lynch MER.N and the Federal Reserve would accept equities in exchange for cash loans for the first time in its history.

While Wall Street stocks were volatile and 10-year U.S. Treasury credit default swaps hit a record wide, the foreign exchange market was not yet fearing a U.S. financial system meltdown, analysts said.

The high-yielding Australian and New Zealand currencies fell sharply versus both the U.S. dollar and the Japanese yen.